Jared Pilon
Imagine selling the business you’ve spent decades building for millions of dollars, and then discovering that one of the most valuable tax exemptions available to Canadian business owners is not available to you. The only thing you did wrong was assuming your corporation automatically qualified before the sale happened.
It is one of the most common questions I am asked: "I have a corporation. Does that mean I receive the Capital Gains Exemption when I sell?"
The answer is no. Before you assume the exemption is waiting for you, ask yourself one question: Do the shares of my corporation qualify today?
If you cannot answer that clearly, keep reading.
What is the Lifetime Capital Gains Exemption?
The Lifetime Capital Gains Exemption, or LCGE, is currently $1.25 million for qualifying incorporated businesses. If your shares qualify, the exemption can potentially shelter a significant portion of the capital gain you retain when you eventually dispose of them.
However, there is a catch. You have to qualify. Specific rules must be satisfied before your shares are treated as qualified small business corporation shares, and those rules consider ownership periods, the assets held inside your corporation, and how they have been used.
Some of those rules look back over the history of your business. That is the detail business owners tend to miss.
This Is Exit Planning, Not Sale Planning
Whether you realize it or not, you will eventually exit your business. Perhaps you will sell to a competitor, transfer it to your management team, or pass it to your children.
Perhaps you will own it for the rest of your life. Even then, there is still an exit. When you die, Canadian tax rules can result in a deemed disposition of your shares. That is why I do not treat this solely as sale planning.
What Planning Ahead Looks Like
Time Creates Options
I worked with a client whose operating company had accumulated passive investments that were creating concerns from an LCGE perspective. No sale was happening, and that was the advantage. We had time.
We completed a corporate reorganization, moved those passive investments out of the operating company as part of a broader purification strategy, and continued to monitor the structure. Just after the two-year mark, the client received and accepted an offer to sell.
Because the planning was already done, the client could report the sale as qualified small business corporation shares. Had we waited until the offer arrived to ask the question, that would have been a very different conversation.
The Exit You Never Planned For
When I raise this issue with owners, the response is often, "But I am not selling." That is fine. Selling is not the only event we are planning for.
I am currently working with a client where we considered what could happen if both spouses were to pass away while the shares did not qualify. Based on their circumstances, the estate could face roughly $300,000 more in taxes than if the shares do not qualify.
There is no buyer in that example. It is just the tax consequence that arises because every owner exits one way or another.
Common Mistakes Business Owners Make
The first mistake is assuming you will address tax planning when you are ready to sell. But what happens if you are not the one who determines the timing? A competitor makes an offer too good to ignore, or your health changes. Suddenly the succession plan you had disappears, and the only question that matters is whether your business is ready today.
The second is assuming your industry qualifies you. This comes up regularly with farms. These businesses have their own rules, and qualifying farm properties held personally can involve a different analysis than shares of a corporation carrying on a farming business. If you have incorporated your farm, do not assume the shares will automatically qualify.
The third is treating this as a one-time exercise. Excess cash, an investment portfolio, or other passive assets can accumulate inside your company and affect whether your shares still satisfy the required tests. That is how a successful business can create its own tax planning problem. LCGE planning is not something that happens once. It should be monitored.
Ask Your Accountant One Question
None of this information means every corporation can or should be reorganized to qualify. Do not create complexity unless there is a reason to do so. The objective is to understand what you are trying to accomplish and then build the structure that supports it.
But if the exemption could provide a significant benefit to you or your family, that is a very good reason to determine whether your shares currently qualify. If they do not, you should understand why. Perhaps something can be done. Perhaps it cannot. Perhaps it can be done today but will take time for the conditions to be satisfied. The important thing is knowing, because uncertainty is much easier to address five years before a transaction than five weeks before one.
So if you do one thing after reading this, ask your accountant whether your corporation's shares qualify for the Lifetime Capital Gains Exemption today. That conversation may uncover one of the most important succession planning opportunities available to you.
Legacy Accounting LLP works with business owners at every stage of that conversation, from corporate structure reviews to full succession planning. If you would like to discuss where your business stands today, contact our team today.
Want to explore the Capital Gains Exemption further? Listen to Legacy: The Business Succession Podcast
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